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When Will Royal Dutch Shell Raise Its Dividend?

Aristofanis Papadatos: Nov 16, 2017

Summary

  • Royal Dutch Shell has not cut its dividend since World War II.
  • However, the company has paid the same dividend for 15 consecutive quarters.
  • Therefore, the big question is if and when its shareholders should expect the next dividend hike.

Royal Dutch Shell (RDS.A) (NYSE:RDS.B) offers a generous dividend yield, which currently stands at 5.9%. Nevertheless, the oil major has paid the same dividend for 15 consecutive quarters. Therefore, as most of its shareholders are holding the stock for its dividend, it is only natural that they wonder if and when they should expect the next dividend hike.

First of all, Shell has an enviable record in dividend payments to its shareholders. To be sure, the company has not cut its dividend since World War II. This achievement certainly confirms the exceptional business performance of the company. However, the company has markedly slowed its dividend growth rate during the last decade, as it has raised it by only 2.7% on average during this period.

In addition, like the other oil majors, Shell has been pressured to a great extent by the prolonged downturn of the oil market and hence it has frozen its dividend for 15 consecutive quarters. More precisely, the company posted free cash flows of only $3.7 B in 2015 and -$1.5 B last year, which were clearly insufficient to cover the annual dividend payments of about $16 B. Consequently, the net debt (as per Buffett, net debt = total liabilities – cash – receivables), which also increased due to the acquisition of BG, has almost doubled in the last few years, from $87.8 B in 2012 to $150.1 B in the most recent quarter. The steep increase in the debt load has also resulted in doubling the annual interest expense of the company, which currently stands at $3.0 B. Therefore, the company has to reduce its debt load in order to reduce its leverage and its exposure to any unforeseen headwinds.

On the other hand, the company has taken the right measures during the ongoing downturn in its sector and hence it now seems to have left the worse behind. More precisely, it has reduced its operating expenses by approximately 25% during the last three years while it has also curtailed its capital expenses by 1/3. As a result, it has managed to achieve free cash flows of $16.8 B in the last 4 quarters, which are sufficient to fund the dividend payments. In other words, the company has managed to fully cover its dividend at an average oil price of $51. This achievement only confirms that the company has taken the right steps to withstand the environment of low oil prices. It is also remarkable that Shell has surpassed Exxon Mobil (XOM) in operating cash flows so far this year for the first time in about two decades.

While all the oil majors have enjoyed strong support from their refining segments during the current downturn, Shell has found additional support from its chemical segment. More specifically, while the price of oil is now half of what it was in 2014, the earnings of the chemical segment of the company have doubled, from $1.3 B to $2.6 B in the trailing four quarters. Therefore, this segment provides additional diversification to Shell under the prevailing low oil prices.

It is also worth noting that the management of Shell does not focus merely on the short-term results, like most managements. Instead it maintains a long-term horizon. This is clearly reflected in the recent acquisition of NewMotion, the owner of one of Europe’s largest electric vehicle charging networks. While the current scale of electric vehicles is negligible for an oil major, the management of Shell made this acquisition thanks to its expectations for electric vehicles to comprise about a quarter of the global car fleet by 2040. It is certainly encouraging that the management has such a broad horizon and tries to make the right moves well in advance to position the company before other large companies enter the market.

It is also important to note that the oil major is fine grading its upstream segment in order to be appropriately positioned to benefit from the next upcycle. More specifically, while this segment used to generate the vast majority of the total earnings of the company in the past, it is now only marginally profitable and makes up just 15% of the total earnings. Nevertheless, the management maintains a long-term scope and has thus invested in several blocks in Brazil’s offshore oil sector. In fact, the company secured half of the blocks offered in the tender. More importantly, the management believes that these blocks will prove profitable even at oil prices below $40. Therefore, while the company is disposing non-core assets to preserve its balance sheet, it is also investing in projects with really promising returns.

In reference to the prospects of a dividend hike, although the managements of the other oil majors have emphasized that their top priority is the dividend, the management of Shell has repeatedly stated that its top priority is the reduction of the debt load. Therefore, the management is not likely to raise the dividend for a few more quarters, particularly in the next quarter, when the company expects somewhat lower earnings due to extensive maintenance.

On the other hand, if the price of oil does not fall below $50 for a long period, the company will certainly start to reduce its debt load. Despite the booming shale oil output, the oil market is better balanced now than it was three years ago thanks to the drastic cuts of capital expenses of all the oil producers during this downturn. These cuts will soon start to take their toll on the total supply. Moreover, while the shale oil producers are likely to put a cap on any rally of the oil price, Saudi Arabia will do its best to support the oil price amid the upcoming IPO of Saudi Aramco next year. Therefore, while oil is not likely to return to the $100 level anytime soon, it is likely to remain around $50-$70 for the next few years. Such a range will certainly help Shell improve its balance sheet. In addition, as soon as the company becomes confident that the oil price will not plunge to $40s once again, it is likely to raise its dividend. Therefore, its shareholders can reasonably expect the next dividend hike to be announced during the second half of next year.

To sum up, Shell has taken the right steps in the ongoing downturn of the oil market and thus seems to have left the worse behind. As a result, the oil giant can fully cover its dividend at the prevailing oil prices. Therefore, as the oil market has become more balanced and the oil price is not likely to plunge to low $40s anytime soon, the company will be able to start reducing its debt load and will then be able to raise its dividend, probably in the second half of next year.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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